by Howard Haykin

Earlier this week, Susan Schroeder, EVP for Enforcement at FINRA, spoke about Enforcement Actions and Transparency to attendees of a SIFMA AML conference. Ms. Schroeder had been promoted to that position in July 2017, the same time that FINRA announced plans to merge its two distinct enforcement teams – Market Regulation Legal and Enforcement. 

The following are my take aways on Ms. Schroeder's remarks about Enforcement Actions. [Click below link for full read of Ms. Schroeder’s Speech.] 

In most instances, misconduct doesn’t create quantifiable harm but instead creates risk, whether for a customer, member firm or the industry at large. In such instances, FINRA officials must ask themselves whether the misconduct created significant risk, such that the misconduct requires an enforcement response in order to prevent and deter future harm.

• Risk that is Evidenced by A High Likelihood Of Harm.   For example, a firm employs a number of brokers with sales practice disciplinary histories but fails to implement a reasonable system to supervise those higher risk brokers.

• Risk that is Evidenced by the Potential for Widespread Harm.   When the probability of significant harm is smaller, it can still be significant if the impact would be broad. For example, cases regarding violations of the customer protection rule - e.g., those involving firms’ capital reserves and custody obligations - fall into this area at times. 

• Heightened Risk that is Posed by Intentional or Reckless Misconduct.   Consider two scenarios: (i) Firm A seeks guidance from counsel about what the firm is obligated to do in order to comply with a rule. The firm misunderstands the rule, relies on incorrect guidance in good faith, and subsequently violates the rule. (ii) Firm B doesn’t understand the same rule, but doesn’t seek any guidance, doesn’t take steps to comply and subsequently violates the rule. While both firms technically violated the same rule, Firm A acted in good faith and thus poses far less risk than Firm B, whose intentional or at least reckless noncompliance demonstrates a fundamental disregard for regulatory obligations that could be – and in fact likely is – widespread and pervasive.

• Risk that is Characterized By Recidivism.  Repeated misconduct after disciplinary action indicates reckless or even intentional disregard for regulatory obligations. The notion of recidivism is an important component of our approach to high-risk brokers and high-risk firms. Repeated misconduct is not only a compelling reason for an enforcement response; it also requires progressively escalating sanctions.

• Risk that is Created by a Broad Pattern Of Disregard for Regulatory Requirements.   For example, a firm that violates a number of different rules across the organization, perhaps demonstrating different types of violations year after year. Widespread violations indicate a fundamental lack of supervision, if not disregard for customer protections, that may pose a significant risk even when, by luck or happenstance, no significant harm has yet resulted. In such a case, enforcement action may be appropriate for a failure to implement reasonable supervision even when there has not yet been quantifiable damage.

DETERMINING SANCTIONS IN ENFORCEMENT ACTIONS.    Two things top the list when FINRA has determined that sanctions are an appropriate response:

• The FINRA Sanctions Guidelines offers a laundry list of available options when it comes to sanctions: fines, restitution, disgorgement, expulsions, bars, plenary and principal suspensions, undertakings (such as the undertaking to hire an independent consultant), rescission, requirements to requalify, business restrictions, supervision requirements, pre-approval requirements.

• Sanctions should most affectively address the root cause of the problem, mindful of the fact that a sanction should be proportionate to the harm or risk of harm posed. They should be remedial, and effective deterrents, but should not be excessive to the point of being vindictive. Determining where this line falls is a challenge that FINRA faces every day.